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THE ECONOMIC & FINANCIAL MARKET OUTLOOK THROUGH 2005: What Next For The Post-Election Economy?

THE ECONOMIC & FINANCIAL MARKET OUTLOOK THROUGH 2005: What Next For The Post-Election Economy? A Presentation To The Iowa Chapter Of Financial Executives International Des Moines, Iowa January 20, 2005. THE ECONOMIC-POLICY DEBATE OF 2005.

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THE ECONOMIC & FINANCIAL MARKET OUTLOOK THROUGH 2005: What Next For The Post-Election Economy?

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  1. THE ECONOMIC & FINANCIAL MARKET OUTLOOK THROUGH 2005: What Next For The Post-Election Economy? A Presentation To The Iowa Chapter Of Financial Executives International Des Moines, Iowa January 20, 2005

  2. THE ECONOMIC-POLICY DEBATE OF 2005 * Sharpening A Classic Division Between Republicans And Democrats --What Kind Of “Ownership Society?” * Finding A Balance Between Growth & Inequality Vs. A More Equal, Less Efficient Economy * Ideology Frames The Policy Issues In 2005 --Social Security Reform --Permanent Tax Cuts --Tax Reform

  3. RESPECTABLE, BUT STILL SUB-PAR GROWTH THROUGH 2005Year-Ago Percent Change In Real GDP 7% Avg., Previous 5 Long Cycles* Avg. Annual % Chg., Forecast 6% 1991-2003=3.4% P.A. Current Cycle 5% 4% 3% 2% 1% 0% -1% -2% -1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Quarters Before And After The Start Of A Recovery * Cycles beginning in 1960, 1969, 1974, 1981, 1990. Source: U.S. Department Of Commerce

  4. IOWA'S ECONOMIC RECOVERY LAGS THE NATIONAL AVERAGEPercent Change, Gross Sate/ Domestic Product 4.5% Forecast 4.0% 3.5% 3.0% 2.5% Iowa U.S. 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% 1998- 2001 2002 2003 2004 2005 2006- 2000 08 Sources: Economy.com, Blue Chip Economic Forecast

  5. GAUGING "DISINFLATION'S" IMPACT ON CORPORATE "PRICING POWER," COSTS AND PROFIT Year -Ago Percent Change; Non-Financial Corporations 5% Note: Bars Denote 4% Recession Periods Margin Pressure 3% Selling Prices '04Q3 2% 1% 0% -1% Unit Labor Costs -2% Margin Expansion -3% -4% Mar-89 Mar-91 Mar-93 Mar-95 Mar-97 Mar-99 Mar-01 Mar-03 Mar-05 Source: U.S. Commerce Dep't.

  6. A "YELLOW FLAG" ON INFLATIONYear-Ago Percent Change, Non-Energy CPI Goods Vs. Services Prices 2.0 4.2 Commodities, Ex. Food & Energy 1.5 (Left Scale) 3.9 1.0 0.5 3.6 0.0 -0.5 3.3 -1.0 11/04 3.0 -1.5 -2.0 Services, Ex. Energy 2.7 (Right Scale) -2.5 -3.0 2.4 Jan-1996 Jan-1998 Jan-2000 Jan-2002 Jan-2004 Source: U.S. Dep't Of Labor

  7. INVENTORIES STILL "LEAN" OUTSIDE THE AUTO INDUSTRYRatio Of Inventories To Sales 1.800 1.550 Autos 1.500 (Left Scale) 1.690 1.450 1.400 1.580 1.350 11/04 1.470 1.300 1.250 1.360 1.200 Excluding Autos (Right Scale) 1.250 1.150 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Source: U.S. Department Of Commerce

  8. U.S. EXPORTS RESPOND TO A WEAKER DOLLAR % Rept'g An Increase Index: 2000=100 64 112 Export Orders, Mfd. Goods 110 (Left Scale) 62 108 12/04 60 106 58 104 102 56 100 54 98 52 96 94 50 92 "Real Trade-Weighted" 48 $* 90 (Right Scale) 46 88 1/14/05 44 86 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 * Based on the dollar's inflation-adjusted, trade-weighted exchange rate against 44 other currencies. Sources: Nat'l Ass'n Of Purchasing Mgrs.; J.P. Morgan & Co.

  9. RAPID-FIRE RATE HIKES FOLLOW AGGRESSIVE POLICY STIMULUSThe Federal Funds Rate Less The PCE "Deflator;" Percent 5.0 4.0 3.0 Avg., 1969-2003=2.6% 2.0 Fed "Easing" During The Sluggish 1.0 1991-92 Recovery 12/04 0.0 Note: Bars Denote -1.0 Recession Periods -2.0 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Sources: Bloomberg Financial News, Inc., U.S. Commerce Dep't

  10. A REPLAY OF THE 1999-2000 INTEREST-RATE “UP CYCLE?” The Treasury Yield Curve, Selected Periods; Yields In Percent 7.3 Federal Funds Target Rate, 5/18/00 5/16/00=6.50% 6.3 6/29/99 5.3 Fed Funds Target Rate, 11/18/98 11/17/98=4.75% 4.3 0 5 10 15 20 25 30 35 Years To Maturity Source: Bloomberg Financial News, Inc.

  11. “RISKS” IN THE OUTLOOK * “LOW-QUALITY” SECTORS UNDER FIRE * THE HOUSING “BUBBLE” BURSTS * A DOLLAR TAILSPIN *OIL-PRICE VOLATILITY * A CHINESE GROWTH RECESSION * TERRORISM & OTHER GEO-POLITICAL STRAINS * “BUSH II” ECONOMIC POLICIES

  12. FISCAL DEFICITS: IN THE EYE OF THE STORM?Budget Surpluses & Deficits As A % Of GDP; Fiscal Years 3% Forecast, 2006-10 2% 1% 0% No Tax Chgs.=2.3% Of -1% GDP Avg. 1982-92=4.3% Of GDP -2% -3% -4% -5% Wi. Tax & Soc. Sec. -6% Chgs.=3.7% Of GDP -7% 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: Congressional Budget Office & WCM Estimates

  13. HOPEFUL SIGNS OF AN APPROACHING TURN IN THE U.S. BALANCE-OF-PAYMENTS DEFICIT Percent Of GDP* Index: 2000=100* 6% 115 '04Q3 5% 110 4% 105 3% 100 U.S. Payments Deficit (Left Scale) 2% 95 Trade-Wtd. U.S. $ (Right Scale) 1% 90 1/14/05=87.9 0% 85 -1% 80 Dec-84 Dec-87 Dec-90 Dec-93 Dec-96 Dec-99 Dec-02 * Four-quarter moving averages; trade-wtd. $ adjusted for relative inflation rates. Source: U.S. Commerce Dep't

  14. IS FOREIGN CONFIDENCE IN THE U.S. STILL INTACT?Net Foreign Direct Investment In The U.S. Plus Foreign Private Portfolio Investment; $ Billions 120 Rolling 4-Quarter 100 Average '04Q3 80 60 40 Rolling 5-Year Moving Average 20 0 -20 Mar-85 Mar-88 Mar-91 Mar-94 Mar-97 Mar-00 Mar-03 Source: U.S. Commerce Department

  15. THE OUTLOOK FOR S&P 500 EARNINGS GROWTH STILL FAIRLY UPBEATYr.-Ago % Change In S&P 500 Operating Profits* 27% Forecast* 22% Avg. Annual % Chg., '04Q3-'05Q4 1983-2003=7.2% 17% 12% 7% 2% -3% -8% -13% -18% -23% Mar-97 Sep-98 Mar-00 Sep-01 Mar-03 Sep-04 Mar-06 * First Call "bottom-up" consensus estimate, including goodwill adjustments. Source: First Call, Inc.

  16. S&P 500 PRICE-EARNINGS (P/E) MULTIPLE NOT UNUSUALLY HIGH... S&P 500 P/E Multiple, Based On Consensus, "Bottom-Up" Operating. Earnings Forecasts 27 S&P 500 P/E Multiple (Left Scale) 23 1/14/05 P/E=16.1x Avg. P/E, 1983-2003=14.9 Times 19 Forward Operating Earnings 15 11 7 3 Jan-79 Jan-83 Jan-87 Jan-91 Jan-95 Jan-99 Jan-03 Sources: Standard & Poors, Inc., IBES, Federal Reserve Board

  17. …AND STILL "CHEAP" AGAINST BONDS, AT CURRENT INTEREST RATESRatio, 10-Yr. Treasury Yield Vs. Earnings-Price Yield (E/P) On S&P 500 Stocks 1.8 1.6 1.4 Avg., 1983-2003=1.016 1.2 1.0 1/14/05 0.8 0.6 0.4 Jan-79 Jan-83 Jan-87 Jan-91 Jan-95 Jan-99 Jan-03 Sources: Standard & Poors, Inc., IBES, Federal Reserve Board

  18. BOND MANAGERS POSITIONED FOR HIGHER INTEREST RATES RATES Portfolio "Duration" Vs. Target, In Percent; 4-Wk. Moving Avgs. 104 103 102 101 100 99 "Neutral" (100% Of 12/14/04 Benchmark Duration) Week 98 97 96 95 94 25-Dec-01 25-Jun-02 24-Dec-02 24-Jun-03 23-Dec-03 22-Jun-04 21-Dec-04 Source: Stone McCarthy Research Associates, Inc.

  19. LOW TREASURY YIELDS VS. DURATION INCREASE THE RISK OF NEGATIVE RETURNS Duration (In Years) Yield (In Percentage Points) 8 5-Yr. Treasury Yield 7 6 5 11/04 4 5-Yr. Treasury Duration 3 2 Dec-92 Dec-94 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Source: Merrill Lynch, Inc.

  20. COMPETING IN A DYNAMIC GLOBAL ENVIRONMENT * GLOBAL COMPETITION’S SILVER LINING --Ongoing Pressure To Boost Productivity Growth Via Tech Investment, Management & Other Innovations * “MUTED” BUSINESS CYCLE * MORE FAVORABLE DEMOGRAPHICS * THE BENEFITS OF A MORE “MARKET-ORIENTED” FORM OF CAPITALISM --Entrepreneurship & Innovation, More Open, Dynamic Labor & Financial Markets, More Pro-Active Economic Policies

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